The Super Fund: Panacea or Placebo

What is the impact that New Zealand’s aging population will have on the ability to pay New Zealand Superannuation.

Wednesday, June 20th 2001, 3:29PM

What's
the bottom line? More needs to be done.
With an aging population the cost of funding retirement income
in New Zealand is set to increase steeply over the next 50 years.
Irrespective of the 'Super Fund', future taxpayers will bear
a large part of this burden and there will be a massive and growing
inter-generational transfer of wealth.

Higher economic growth and more labour force
participation are the key means by which NZS will be sustainable
in the future. In turn, these factors depend on individuals'
incentives to invest and work in New Zealand.

While the proposed Super Fund is one idea
on how to partly fund future NZS commitments, it brings with it
significant risks and costs. Meanwhile, the real issues about
promoting economic growth and employment are more related to the
design of NZS, not the funding.

We offer some ideas for change in the future
related to the design of NZS and the process.

Public retirement income and moral hazard
One of the most common goals amongst OECD countries is the provision
of an adequate retirement income for its citizens. New Zealand
is no exception and has chosen as its first tier of retirement
income a publicly funded scheme.

However, the provision of a publicly funded
retirement income comes with a twist. If the general public believes
that government will provide them with a reasonable retirement
income, then the individual incentive to invest smart for retirement
is reduced. The trick for government then is to strike a balance
between providing a retirement income for those in need, while
maintaining incentives to invest and work as an individual.

In New Zealand, the first tier of retirement
income provision is NZ Superannuation (NZS). This is a 'pay as
you go' scheme funded from the current tax take. People are also
urged through public education and a host of other policy efforts,
to generate other forms of long-term savings. That is, to create
a second-tier of retirement income.

In providing NZS, the government must try
to balance:

A retirement income level which the genuinely
needy can survive on, and interest groups will accept; while

Ensuring private saving and investment
incentives remain strong.

But, if NZS is too generous then it will
weaken an individual's investment incentive and the second-tier
of retirement income will dwindle. In addition, it is unclear
just what the capacity of NZ households' is to build a second
tier of retirement income. Furthermore, with an aging population,
the cost of NZS is set to rise significantly over the next few
decades.

These factors highlight why it is the design
of NZS that is crucial to ensuring an adequate level of retirement
income for all NZ citizens in the future, rather than its funding.

The aging population
It is estimated for New Zealand that the proportion of the population
aged 65 years and over is to increase from 12% now to 27% over
the next 50 years. It is thus estimated that the annual cost of
NZS will rise from 4% of GDP now to over 9% by 2050.

Such a large inter-generational transfer
of wealth may prove unsustainable in both an economic and political
sense. Future taxpayers may be unprepared to pay the required
tax and vote with their feet. More likely, other forms of tax
revenue will be sought, or the generosity of NZS will alter (i.e.,
be 'needs tested'). For example, in anticipation of these events,
Family Trusts and other forms of asset protection are growing
rapidly.

The proposed Super Fund: Panacea?
Given this projected rise in the cost of NZS, the Government has
proposed the establishment of a new 'Super Fund' to part pre-finance
it in years to come. Annual contributions of tax revenue will
be paid into the fund starting this fiscal year.

However, at its peak, the fund will cover
only 14% of the entire cost of NZ superannuation - if all goes
well. The fund is thus best regarded as smoothing the 'pay-as-you-go'
public retirement income system. Meanwhile, the burden of NZS
will continue to grow in the absence of any design changes.

Placebo?
The Government's proposed 'tax smoothing' fund aims to create
more certainty about the availability of future NZS. But, does
it really do this and any more so than other alternative uses
of tax revenue?

First,
even with the introduction of the fund, the ability to pay for
future NZS is still entirely dependent on the size of the tax
base at the time. Meanwhile, the 'opportunity costs' of that
taxpayers money goes unknown. Alternative uses of government revenue
exist, such as reducing the tax rate or government debt, or increasing
spending on education - all of which boost economic growth. These
policy alternatives can be managed while still providing NZS to
those in need.

Given that the 'super fund' concentrates
on funding rather than design issues, it is unlikely that the
proposal will boost economic growth or labour force participation
by more than the alternatives.

Second,
the proposed retirement income scheme will not raise the pool
of savings in New Zealand. Instead, it is only likely to alter
the form of saving. Government saving will remain the same, with
no increase in revenue or reduction in expenditure committed to.
In fact, the creation of the fund could dent people's willingness
to save and invest smart as individuals, given the moral hazard
discussed earlier.

Third,
the Government is taking more financial risk onto their balance
sheet (as opposed to paying down public debt) which implies no
risk-adjusted gain on the use of tax revenues. Meanwhile, the
fund will create costs in terms of parliamentary time and focus,
publicity, management and salary costs, and other compliance costs.

Fourth,
the incentive structure for the funds' managers appears weak.
Even with the fund, future retirement income remains underwritten
by the government's ability to raise tax revenue - not on the
returns of the fund.

Fifth,
it is difficult to see how or why the proposed fund could be modified
to include individual accounts. The incentives for individuals
to save and invest wisely would remain the same since:

The amount paid into the fund would remain
the same (i.e., not actuarily assessed);

And, the retirement income paid out would
be the same (i.e., not 'needs based').

Practical issues would also remain, such
as who qualifies for an account, when can people get access to
these funds, and what would happen if someone leaves the country
or dies early?

Overall, we believe that while partly assisting
the funding, the proposed 'Super Fund' appears costly and risky,
and does not build on the relative competencies of the public
and private sectors.

Moving forward - a partnership solution
Under the current level of generosity, the cost of completely
pre-funding the future liability of NZS is already too great for
the economy to manage. In order to meet the growing NZS payment
either:

Economic growth must rise;

More people need to remain in the labour
force;

NZS will need to become less generous;
and/or

More saving will need to be made now to
partly pre-fund the future costs.

In other words, we need to search for the combination of policies
that best encourages wealth creation and labour force participation,
while also providing an adequate retirement income to those in
need.

The focus of public policy on superannuation
over recent years has been on creating the necessary conditions
to ensure that individuals save and invest. These efforts have
revolved around: public education, ensuring a competitive funds
management industry and an adequate range of savings products,
improving the neutrality of the tax system, and building on the
credibility of public policy. While there appears no reason to
dilute or compromise this good work, there are strong reasons
to supplement it.

For example, the key focus of the funds
management industry has been on people in the upper end of the
income scale or in some employer schemes. However, from a public
policy perspective, it is the middle and low income New Zealanders
whose retirement income provision needs attention. People in these
income groups are well aware of the need for long-term savings,
but are neither well informed about the options, nor able to afford
it. Several policy options are possible, as discussed below.

The first tier of income
The NZS could persist as is. However, the generosity of the NZS
would need to change as it becomes expensive with an aging population.
This means immediate discussion is necessary on the design of
NZS, rather than debating its funding. The issues include the
state pension age, dollar amount paid, inflation linkage, generosity
of the NZS compared to other forms of welfare, and qualifications
for payment - including needs testing. For example, it is sensible
that someone wealthy is being subsidised in retirement by someone
earning a below average wage? Or, why are NZS payments more generous
than welfare payments to someone who is disabled or unemployed?
And so on.

If NZS changes prove equitable and efficient
(they are necessary), then they should be confronted as early
as possible. The current working population should be given every
opportunity to prepare for their retirement, with adequate time,
information and savings vehicles.

The 'Todd Taskforce' canvassed these issues
in the 1990s and the 'Retirement Income Commission' appears more
than capable of leading the debate in a bipartisan fashion.

A second tier?
If we are interested in design modifications to NZS then there
are many variants more efficient than the Super Fund. For example,
the government could provide a retirement-income subsidy for middle
and low-income New Zealanders, which mimics the current employer-based
schemes. For every dollar saved by an individual below a certain
income level, the government could match it dollar-for dollar
until a long-term savings level is reached that provides an annuity
in retirement.

The savings would not be accessible until
retirement age and the payment would be as an income stream, rather
than a lump sum. Meanwhile, the current NZS could be left purely
for those people not in the labour force for whatever reason.

In such a system, individual names are attached
to the savings, and the private sector is competing to manage
the funds and calculating the annuities actuarially correctly.
Meanwhile, government support is better targeted, and moral hazard
in terms of saving and investment decisions are minimised.

The overall retirement income system would
also be more affordable, efficient, and arguably equitable. The
public and private sectors are both using their relative expertise.
The funds are privately managed and long-term savings goals are
met accordingly. And, fund managers are left with very strong
incentive structures to perform well as future retirement income
levels will depend on them.

The system remains flexible for future changes
to generosity of the scheme and there is no need to create an
independent government structure. The system can be implemented
using the current tax collection system. Also, those who do not
earn any income for whatever reason will not be disadvantaged
since the current NZS could still be available as a retirement
income of last resort. Finally, the most important outcome is
that incentives to save and invest smart remain strong and on
the individual.

Of course, the devil is in the start up
detail of such a scheme. But being tough to start is no excuse
for not starting - especially in this $5 billion industry.

The bottom line
No matter what the NZS system, New Zealanders will need to rely
on several levels of retirement income provision. By the time
the current workers are all retired, these incomes may include:

Some form of 'needs tested' public retirement
income;

Possibly a government supplemented individual
retirement scheme; and

Various other forms of private savings.

Amongst this combination, the proposed Super
Fund is not the make or break of retirement income provision.

Since it is future taxpayers that will face
the growing NZS commitments, in order to make sustainable changes
now a bipartisan political approach appears necessary. Otherwise,
it will remain too easy for the current generation to vote for
the most generous future offerings - the temptation to 'take the
candy from the baby' will dominate.